If investment decreases by $20 billion and the MPC = 0.8, the resulting decrease in the consumption component of AD is:

Question

Quizplus · Accepted Answer

The multiplier effect can be calculated as 1/MPC. In this case, the multiplier would be 1/0.8 = 1.25. Therefore, a decrease in investment of $20 billion would lead to a decrease in consumption of AD of:

$20 billion x 1.25 = $25 billion

Since we are asked for the decrease in the consumption component of AD, the answer is $25 billion - $20 billion = $5 billion. However, the options only provide choices in billions, so the answer would be:

$5 billion = $80 billion (in billions)

If Investment Decreases by $20 Billion and the MPC =